Accounting for LEASES
IAS 17
IAS 17
• IAS 17 Leases sets out the treatment for
reporting lease transactions in the financial
statements.
• Leases are a major source of finance to a
business and it is important that the financial
statements disclose sufficient information to
the readers of the financial statements.
Doesn’t cover:
• Leases to explore or use mining, oil, gas
resources
• Licencing agreements such as: motion picture
films, plays, patents, copyrights
• Property held by a leasee that is accounted for
as an investment property
• Biological assets held by leasee under finance
leases or operting leases.
2 Types
• IAS 17 distinguishes between two types of
lease transactions:
• A finance lease
• Operating lease
Substance over form
• Substance over form
• Information in the financial statements should
represent transactions in accordance with their
commercial substance not merely their legal
form. Eg lease vs rental
• The accounting for leases is the application of this
concept, as the classification of a lease as either a
finance lease or an operating lease, depends on
the substance of the transactions rather than the
legal form of the contract.
Finance Lease
• A finance lease “is a lease that transfers
substantially all the risks and rewards inherent
to ownership of the asset”.
Operating lease
• An operating lease is a lease other than a
finance lease.
• The classification of a lease is crucial, as
different accounting, approaches are required
for the different types of leases.
Characteristics that imply a Finance
Lease
1. Ownership of the asset will pass to the lessee at
the end of the lease.
2. The lessee has an option to purchase the asset at
a cost significantly below the fair value of the asset.
3. The term of the lease is for the major part of the
economic life of the lease.
4. On commencement, the present value of the
minimum lease payments amounts to substantially
all the minimum fair value of the lease. 90% - The
leasee is paying all of the fair value or cost of the
asset over the life of the lease
5. The lease assets are of a special nature. Only the
leasee can use them without substantial modification
6. The Leasee is entitled to cancel the lease.
7. If a lease transfers substantially all the risks and
rewards, associated with ownership of an asset the lease
should be classified as a finance lease.
• Risks involve meeting the costs of maintaining the
asset or suffering the fall in value of the asset through
technological obscelecence.
• Rewards include using the asset for substantially the
whole of its useful life, and accruing the profits from
the use of the asset
8. Gains or losses from the residual value of the
asset fall to the leasee.
9. Whether the lessee has the option to extend
the lease for a secondary period at a
“peppercorn rent” (below the market rent).
All characteristics do not need to be present
Accounting for Finance lease
• Debit leased asset account (Leased Asset)
• Credit the Finance Lease account (Long term liability)
At the lower of:
The fair value of the leased asset or
the present value of the minimum leased payments
Any direct costs of the lease are added to the amount
recognised as an asset eg interest
Yearly interest is to be charged to each period during the lease
so as to produce a constant periodic rate of interest on the
remaining balance
Accounting for Finance lease
• The asset is depreciated over:
– The assets estimated useful life
– Or the term of the lease
Whichever is shorter
Calculating Interest – 2 Methods
• Actuarial Methods
The actuarial method charges interest at a constant percentage on the
outstanding liability and matches the interest to the loan balance. The
rate of interest implicit in the lease is required. The interest charged for
each period is the interest rate multiplied by the balance remaining
immediately after the rental payment is made.
• Sum of the Digits Methods
This method approximates the interest charge for each period by
weighting the period in reverse order so that the most interest is charged
in earlier periods.
5 year lease: 5+4+3+2+1 = 15
year 1: 5/15 of interest
year 2: 4/15 of interest etc
(½ x n) x (n+1) where n is number of instalments
ABC Ltd entered into a fiver year lease for a new machine on
1/1/2011. ABC Ltd has to make 5 annual payments of €30,000
payable in advance. The present value of the minimum lease
payments is €125,096. The implicit interest rate is 10%
Year
2011
2012
2013
2014
2015
Present Value
125,096
104,606
82,067
57,274
30,000
Advance pay
30,000
30,000
30,000
30,000
30,000
95,096
74,606
52,067
27,274
0
Interest 10%
9,510
7,461
5,207
2,726
Owing
104,606
82,067
57,274
30,000
0
Finance Lease Account
DATE
DETAILS
1/1/11
Bank
31/12/11
Balance
€ DATE
30,000 1/1/11
104,606 31/12/11
DETAILS
Machinery
Interest
134,606
€
125,096
9,510
134,606
1/1/12
Bank
30,000 1/1/12
Balance
104,606
31/12/12
Balance
82,067 31/12/12
Interest
7,461
112,067
112,067
1/1/13
Bank
30,000 1/1/13
Balance
82,067
31/12/13
Balance
57,274 31/12/13
Interest
5,207
87,274
87,274
1/1/14
Bank
30,000 1/1/14
Balance
57,274
31/12/14
Balance
30,000 31/12/14
Interest
2,726
60,000
1/1/15
Bank
31/12/15
Balance
60,000
30,000 1/1/15
31/12/15
30,000
Balance
30,000
Interest
30,000
ABC Ltd entered into a fiver year lease for a new machine on
1/1/2011. ABC Ltd has to make 5 annual payments of €30,000
payable year end. The present value of the minimum lease
payments is €113,724. The implicit interest rate is 10%
Year
2011
2012
2013
2014
2015
Present Value
113,724
95,096
74,606
52,067
27,274
Interest 10%
11,372
9,510
7,461
5,207
2,726
125,096
104,606
82,067
57,274
30,000
Payments in arrears
30,000
30,000
30,000
30,000
30,000
Owing
95,096
74,606
52,067
27,274
0
Finance Lease Account
DATE
DETAILS
€ DATE
DETAILS
31/12/11
Bank
30,000 1/1/11
Machinery
31/12/11
Balance
95,096 31/12/11
Interest
125,096
€
113,724
11,372
125,096
31/12/12
Bank
30,000 1/1/12
Balance
95,096
31/12/12
Balance
74,606 31/12/12
Interest
9,510
104,606
104,606
31/12/13
Bank
30,000 1/1/13
Balance
74,606
31/12/13
Balance
52,067 31/12/13
Interest
7,461
82,067
82,067
31/12/14
Bank
30,000 1/1/14
Balance
52,067
31/12/14
Balance
30,000 31/12/14
Interest
5,207
57,274
31/12/15
Bank
31/12/15
Balance
57,274
30,000 1/1/15
31/12/15
30,000
Balance
27,274
Interest
2,726
30,000
Finance Lease Disclosure
• The company needs to disclose the net carrying
amount of the asset held under a finance lease (split
between their current and non-current components),
• present a reconciliation of the future minimum
payments due at the end of the reporting period, and
allocate these values to:
1. within one year
2. within two to five years
3. after more than five years
• A description of the company’s significant lease
arrangements should be presented.
Operating Leases
• Any lease agreement falling outside the
requirement of a finance arrangement is an
operating lease.
• The asset is treated as if it is not purchased.
• Payments (rent) are charged against profit each
year.
• DR
Operating Lease A/C (P&L)
• CR
Bank
• 3 year lease payable as follows:
• Year 1 31/12/11 18,000
• Year 2 31/12/12 16,500
• Year 3 31/12/13 16,500
TOTAL
51,000 / 3 = 17,000 write off each year
Operating Lease Account
DATE
DETAILS
31/12/11
Bank
€ DATE
18,000 31/12/11
31/12/11
DETAILS
P&L
Balance
18,000
31/12/12
Balance
31/12/12
Bank
1,000 31/12/12
16,500 31/12/12
Balance
31/12/13
Bank
500 31/12/13
16,500 31/12/13
17,000
31/12/11 €1000 PREPAYMENT
31/12/12 €500 PREPAYMENT
17,000
1,000
18,000
P&L
Balance
17,500
31/12/13
€
17,000
500
17,500
P&L
17,000
Balance
17,000
Operating Lease Disclosure
1. The total operating lease rentals paid during
the year
2. If there are any operating leases that will last
more that 1 year
3. Commitments should be broken down
between leases that expire within one year,
2-5 years, greater than 5 years.